The Special Loan All Successful Investors Use
Most people understand how a principal and interest home loan works. In simple terms this is the most common form of home loans, and means, for example, that if you have a $300,000 home loan over a term of 30 years based on a variable rate of 6.5%, the required monthly repayment will be $1896.20. If economic conditions were to remain stable for the entire 30 years then the monthly repayment would always be $1896.20 and you would pay the loan off in exactly 30 years.
Of course, in the real world this does not happen as interest rates change from year to year making the required monthly repayment change in accordance with the rate variations.
Many people also choose to make extra repayments on a home loan and this means that the term of the loan reduces accordingly.
But there is another class of home loan which works in a different way. It is called a line of credit. A line of credit is most useful for investors as they utilise equity in their own property to purchase an investment property. When set up as a separate loan account it makes the accounting process a lot easier and provides the investor with a snapshot of the financial position of the investment.
A line of credit is an interest only facility which means that the borrower only has to pay the interest on the outstanding debt. This is a standard accounting tactic as well because the interest on an investment property is tax-deductible. When it comes to completing tax returns, the line of credit statement provides a ready summary of interest paid.
Let’s look at an example. Say an investor owns his own house which is valued at $800,000 and he wants to purchase an investment property for $400,000. Assuming he has the income and credit worthiness to satisfy them makes criteria he can set up a line of credit for 80% of the value of his house, in this case $640,000.
Once approved this gives the borrower immediate access to $640,000 by way of a cheque or a simple bank transfer. This means that he can purchase his investment property for $400,000 without having to make another application to the bank. Once his purchase is successful the low credit balance will reflect his $400,000 purchase and at the end of the firstmonth he will be charged interest on $400,000.
He can now credit the same account with the rent he receives from the investment property so that at the end of every month the rental income is noted as a credit and the interest charged will be noted as a debit. If the income exceeds the interest, the balance on his lower credit will go down or, if the interest exceeds the rental income, the balance will increase accordingly.
The flexibility of the line of credit enables an investor to use the money as he sees fit without having to ask the bank for an advance home loan every time he wishes to make a purchase.
